Oil Market Update

A few days back a massively expensive gathering of oil ministers and politicians took place in the Mid-East in opulent surroundings. From the standpoint of the participants this meeting served 2 purposes - it made it look to the poor battered electorates and oil consumers back home that their leaders and rulers were actually doing something, and it also provided the perfect excuse for an enjoyable “junket” at public expense for the delegates, even if they did have to doze through some boring speeches. The reality, of course, is that little of substance was accomplished, so we won’t waste any more time considering these “fundamentals” and will move on immediately to review the charts for crude oil and oil stocks.

On the 7-year chart for Light Crude we can see that traders are currently faced with a tricky situation, for on the one hand oil is now a runaway market, having broken out upside from its long-term uptrend channel that started way back in late 2001 and also from its lengthy intermediate uptrend that began early last year and thus it could accelerate from here into a spectacular spike that would have devastating consequences for the world economy, but on the other hand, it has not yet broken clear of those channels by a convincing margin, and being substantially overbought it could roll over into a hefty reaction. The right way to play this situation is therefore to stay long but have a clear exit strategy involving the use of trailing stops. Before leaving this chart note the current very large gap between the price and the steeply rising 200 and 300-day moving averages and the still heavily overbought MACD indicator at the bottom of the chart.

On the 1-year chart we can see that despite all the media hype the strong uptrend in oil since early February has actually been quite orderly thus far, even if the $5 rise in one day early this month provides early evidence of overheating. This clear uptrend is highly useful to speculators at this point, who need do little more than stay long for as long as the support line of the uptrend remains unbroken, buying with fairly close stops on approaches to the lower support line, and either taking profits on approaches to the upper return line or holding on for the possibility of a wild spike, selling later when it becomes critically overbought.

Whereas oil has bust out of the top of its long-term uptrend channel, oil stocks are currently about in the middle of their long-term uptrend channel, which started early in 2003, much later than that in oil, which began in the Fall of 2001, as we can see on the 7-year chart for the OIX oil index. Tactics for investors and traders holding oil stocks are therefore clear - stay long, building positions when the index approaches the lower support line of the channel with stops below it, and thinning positions on approaches to the top return line. It should only be necessary to consider large scale closing out of positions in the event that the index drops significantly below the support line of the channel.

Despite oil making new highs early this month, oil stocks have not managed to do likewise, following the failure of their steep short to medium-term uptrend in force from mid-March. This breakdown was, of course, collateral damage resulting from the rapid deterioration in the broad stockmarket during this period, which accounts for the recent underperformance of oil stocks relative to oil itself. Nevertheless, as we have already observed on the long-term chart, oil stocks remain in a long-term uptrend and thus, as set out in the previous paragraph, continue to be rated a buy on weakness so long as the long-term uptrend remains unbroken.

There is currently a considerable amount of discussion doing the rounds about whether the gold to oil ratio, now at a historically low reading, will lead to gold going up, or oil going down. There are two points that need to be made regarding this. The first is that oil is a vitally important resource which is the cornerstone of the modern world, the demand for which is continuing to expand and which just happens to be running out. The same is not true of gold. What this means is that the goal posts are moving, and therefore the gold to oil ratio is probably changing permanently in favor of oil. However, this does not detract from the bullish case for gold. Focusing on the gold to oil ratio misses the point, which is that a big reason that both are in powerful bull markets is the continued global expansion of the money supply that is now manifesting as rampant and increasingly intractable inflation. In this situation gold, which is a permanent store of value and therefore can rightly be described as “real money” can only go up, and any attempt to suppress its ascent by government manipulation is ultimately doomed to fail, as a sizeable market will spring up driven by those demanding physical delivery, that will render what amounts to price fixing or suppression obsolete and to the extent that these measures have thus far held the price back, they will have only succeeded in creating a “pressure cooker” effect that will result in explosive upside gains.

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